While it is possible to use performance
appraisal for employee development and feedback purposes solely, many organizations wish to link the appraisal process to
specific reward and incentive outcomes. This is a legitimate objective.
Studies indicate that
employees find the process of appraisal more satisfying and credible
when it is linked to reward outcomes.

The examples given
below are based on a performance appraisal system with a five-point
rating scale and seven performance factors. (Why seven?
Because the underlying method is based on the ANPAS performance appraisal system,
which uses seven performance factors and five-point
Likert-type scales. A rating score of one represents very poor performance, three
is competent and five is excellent. This method of bonus
calculation may be modified to suit any type of
appraisal system involving multiple performance factors and
scores.)

Brief DescriptionThe first step in a bonus plan is to calculate
the Bonus Fund (or budget).
This is the amount of money that the organization is prepared to
allocate for bonus use. Next, an average performance appraisal rating is
determined for each employee. If an employee scores higher than a
pre-determined level, he or she is eligible for the bonus. The size of the bonus
paid depends on both the performance and the seniority of the
employee.
Finally, a formula allocates the money in the Bonus Fund
to all eligible employees.

1. Calculate the Bonus Fund
The first step is to determine the amount of money available to
pay the bonuses. It is suggested this amount be about 2.5% of
the annual wage and salary bill. This amount is known as the Bonus Fund.

The figure of 2.5% may be varied to reflect the policies, needs and
circumstances of each organization. For example, a percentage of profit
may be preferred, or even a percentage of profit increase.

2. Determine Eligibility
To be eligible, the employee must achieve an Average
Factor Rating of 3.40 or better. The Average Factor Rating is calculated
by summing the ratings and dividing the result by seven.

In this example, an Average Factor Score of 3.71 would make the employee eligible
for the bonus.

3. Select Salary/Seniority Band
There are three Salary Bands, S1, S2, and S3. Employees with
incomes in the higher bands will
receive proportionately larger bonuses. This is necessary to maintain
compensation relativity and provide incentives to employees
on higher incomes. It is up to each organization to decide how it will define the salary
bands. As a guide, the proportion of employees in each Salary Band
should be about S1 60%, S2 30%, and S3 10%. The most common approach is
to define bands according to wage and salary cut-off points; for
example:

The method chosen to
classify employees into Salary Bands is not important, so long as it is
systematic and reflects the general pay and seniority structure of the
organization.

Salary
Band

Value

S1 (lower)

1

S2 (middle)

2

S3 (upper)

3

4. Calculate Individual Bonuses
For each individual, the bonus is calculated by this formula -

This formula will fully
allocate the amount of money available in the Bonus Fund,
regardless of the number of recipients. If there are fewer recipients,
the bonuses for each individual will be correspondingly bigger. For this
reason, it might be wise to have a bonus cap of around 10% per
individual. That is, the maximum bonus payable to an individual
should not exceed 10% of their regular wage or salary. This may result
in a 'leftover lolly' problem, that is, money unallocated. Such residual amounts can be consolidated into
general funds or recycled for bonuses in the next performance period.
This is a matter of policy for each organization to determine.

Example
There are fifteen employees in the Purchasing Department of a
medium-sized organization. The gross annual wage and salary bill for the
employees is $744,000. The Bonus Fund is set at
$18,600 (2.5%).

Among the employees, seven have received Average Factor Ratings of 3.40
or better (therefore they are 'eligible').

Payment of BonusWhile the bonus could be paid in a single lump sum, it is
suggested that multiple smaller payments - bonus instalments
- be paid throughout the next performance period (monthly instalments
are ideal). A number of payments at intervals can do more to strengthen
the link between performance and rewards than a single payment which may be all but forgotten in a short time.

It is recommended that the bonus be paid by way of a separate check, pay
packet or deposit. The payment will lose much of its impact if it is
simply consolidated with normal pay. Every separate payment is a
reminder to the employee of the value of his or her personal effort, and
serves to encourage the type of behavior that leads to superior job
performance.